Cost Mangt CA Accounts

8/14/2019 Cost Mangt CA Accounts

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PAPER - 5 : COST MANAGEMENT

Question 1

(a) Define Total Quality Management? What are the six Cs forsuccessful implementation of TQM ?

(b) What steps are involved in value chain analysis approach forassessing competitive advantages?

(c) Carlon Ltd. makes and sells a single product; the unitspecifications are as follows:

Direct Materials X : 8 sq. metre at Rs 40 per square

metre

Machine Time : 0.6 Running hours

Machine cost pergross hour

: Rs. 400

Selling price : Rs. 1,000

Carlon Ltd. requires to fulfil orders for 5,000 product units perperiod. There are no stock of product units at the beginning orend of the period under review. The stock level of material Xremains unchanged throughout the period.

Carlon Ltd. is planning to implement a Quality ManagementProgramme (QPM). The following additional informationregarding costs and revenues are given as of now and afterimplementation of Quality Management Programme.

Before the implementationof QMP

After theimplementation

1.

5% of incoming materialfrom suppliers scrapped dueto poor receipt and storageorganisation.

1. Reduced to 3%.

2.

4% of material X input to themachine process is wasteddue to processing problems.

2. Reduced to 2.5%

3.

Inspection and storage ofMaterial X costs Re. 1 persquare metre purchased.

3. No change in the unit rate

4.

Inspection during theproduction cycle, calibrationchecks on inspection

4. Reduction of 40% of the existing cost.


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FINAL EXAMINATION : MAY, 2005

equipment vendor ratingand other checks cost Rs.2,50,000 per period

5.

Production Qty. is increasedto allow for the downgradingof 12.5% of the productionunits at the final inspectionstage. Down graded unitsare sold as seconds at adiscount of 30% of thestandard selling price.

5. Reduction to 7.5%

6.

Production Quantity isincreased to allow for returnfrom customers (these arereplaced free of charge) dueto specification failure andaccount for 5% of unitsactually delivered tocustomer.

6. Reduction to 2.5%

7.

Product liability and otherclaims by customers isestimated at 3% of salesrevenue from standard

product sale.

7. Reduction to 1%.

8.

Machine idle time is 20% ofGross machine hrs used (i.e.running hour = 80% of gross/hrs.).

8. Reduction to 12.5%.

9.

Sundry costs of Administration, Selling andDistribution total Rs.6,00,000 per period.

9. Reduction by 10% of the existing.

10.

Prevention programme costsRs. 2,00,000

10.

Increase to Rs.6,00,000.

The Total Quality Management Programme will have areduction in Machine Run Time required per product unit to0.5 hr.

Required:

(a) Prepare summaries showing the calculation of (i) Total

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production units (pre inspection), (ii) Purchase ofMaterials X (square metres), (iii) Gross Machine Hours.

(b) `In each case, the figures are required for the situationboth before and after the implementation of the QualityManagement Programme so that orders for 5,000

product units can be fulfilled.

(b) Prepare Profit and Loss Account for Carlon Ltd. for theperiod showing the profit earned both before and afterthe implementation of the Total Quality Programme.

Answer

(a) The total quality management is a set of concepts andtools for getting all employees focused on continuousimprovement in the eyes of the customer. Quality is animportant aspect of world-class manufacturing. The success of

Japanese companies is grass rooted in their long-termcommitment to improvement of quality. A world classmanufacturing approach demands that the quality must bedesigned into product and the production process, rather than anattempt to remove poor quality by inspection. This means thatthe objectives of quality assurance in a world- class-manufacturing environment, is not just reject defective product,but to systematically investigate the cause of defects so thatthey can be gradually eliminated. Though the goal is zero defect,the methodology is one of continuous improvement.

Six Cs of TQM

(i) Commitment - If a TQM culture is to be developed, so thatquality improvement becomes normal part of everyone's job,a clear commitment, from the top must be provided. Withoutthis all else fails.

(ii) Culture - Training lies at the centre of effecting a change -inculture and attitudes. Negative perceptions must be changed

to encourage individual contributions.

(iii) Continuous improvement - TQM is a process, not aprogram, necessitating that we are committed in the longterm to the never ending search for ways to do the jobbetter.

(iv) Co-operation: The on-the-job experience of allemployees must be fully utilized and their involvement andco-operation sought in the development of improvementstrategies and associated performance measures.

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(v) Customer focus: Perfect service with zero defects in all thatis acceptable at either internal or external levels.

(vi) Control: Documentation, procedures and awareness ofcurrent best practice are essential if TQM implementationsare to function appropriately The need for controlmechanisms is frequently overlooked, in practice.

(b) Most corporations define their mission as one of creatingproducts and services. In contrast, the other companies areacutely aware of the strategic importance of individual activitieswithin their value chain, They are concentrating on thoseactivities that allow them to capture maximum value for theircustomers and themselves.

These firms use the value chain analysis approach to betterunderstand which segments, distribution channels, price points.product differentiation. selling prepositions and value chainconfiguration will yield them the greatest competitiveadvantage.

The way the value chain approach helps these organizations toassess competitive advantage includes the use of following stepsof analysis.

(i) Internal cost analysis - to determine the sources of

profitability and the relative cost positions of internal valuecreating processes;

(ii) Internal differentiation analysis - to understand thesources of differentiation with internal value-creatingprocess; and

(iii) Vertical linkage analysis - to understand therelationships and associated costs among external suppliersand customers in order to maximize the value delivered tocustomers and to minimize the cost.

The value chain approach used for assessing competitive

advantages is an integral part of the strategic planning process.Like strategic planning, value chain analysis is a continuousprocess of gathering, evaluating and communicating informationfor business decision-making.

(c) (a)

Existing After

TQM

Program

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me

i. Total production

units

(Preinspection)

Total sales

requirements

5,000 5,000

Specification losses

5%

250 2.5% 125

5,250 5,125

Downgrading atinspection

5.87

5.12

5,250

750

5.92

5.75,125

416

Total units before

inspection

6,000 5,541

ii Purchase of

material X(Sq

Mtr)

Material required to

meet pre inspection

production

requirement 6,000

8 SqMtr

48,000

SqMtr

5,5418

SqMtr

44,328

SqMtr

Processing loss 96

4

48,000

2,000

5.97

5.244,328

1,137

Input to the process 50,000 45,465

Scrapped material

95

550,000

2,632

97

345,465

1,406

Total purchases 52,632 46,871

iii Gross Machine

Hours

Initial requirements

6,000 0.6

3,600 5,541 0.5 2,771

Idle time 80

203,600

900

5.87

5.122,771

396

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Gross time 4,500 3,167

(b) Profit and loss statement

Rs Rs

Sales revenue 5,000

Units Rs 1,000

50,00,000

50,00,000

Sales downgraded

750 UnitsRs 700

5,25,000

416 Units Rs

700

2,91,200

55,25,000

52,91,200

Costs:

Material 52,632 Sq Mtr

Rs 40

21,05,280

46,871Sq Mtr

Rs 40

18,74,840

Inspection and storage

costs 52,632 Sq Mtr Re

1

52,632 46,871Sq Mtr

Re 1

46,871

Machine cost 4,500 Hrs

Rs 400

18,00,000

3,167 Hrs Rs

400

12,66,800

Inspection and othercost

2,50,000

2,50,000 60% 1,50,000

Product liability (3%

50,00,000

1,50,000

1% 50,00,000 50,000

Sundry cost of selling,distribution andadministration.

6,00,000

6,00,000 90% 5,40,000

Preventive programme

cost

2,00,0

00

6,00,000

51,57,912

45,28,511

Net profit 3,67,088

7,62,689

Question 2

(a) C Preserves produces Jams, Marmalade and Preserves. All theproducts are produced in a similar fashion; the fruits are cooked

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at low temperature in a vacuum process and then blended withglucose syrup with added citric acid and pectin to help setting.

Margins are tight and the firm operates, a system of standardcosting for each batch of Jam.

The standard cost data for a batch of raspberry jam are

Fruits extract 400 kgs @ Rs. 16 per kg.

Glucose syrup 700 kgs @ Rs. 10 per kg.

Pectin 99 kgs. @ 33.2 per kg.

Citric acid 1 kg at Rs. 200 per kg.

Labour 18 hours @ Rs. 32.50 perhour.

Standard processing loss 3%.

The climate conditions proved disastrous for the raspberry crop.As a consequence, normal prices in the trade were Rs. 19 per kgfor fruits abstract although good buying could achieve somesavings. The impact of exchange rates for imported sugar plusthe minimum price fixed for sugarcane, caused the price ofsyrup to increase by 20%.

The retail results for the batch were

Fruit extract 428 kgs at Rs. 18 per kg.

Glucose syrup 742 kgs at Rs. 12 per kg.

Pectin 125 kgs at Rs 32.8 per kg.

Citric acid 1 kg at Rs. 95 per kg.

Labour 20 hrs. at Rs. 30 per hour.

Actual output was 1,164 kgs of raspberry jam.

You are required to:

(i) Calculate the ingredients planning variances that aredeemed uncontrollable.

(ii) Calculate the ingredients operating variances that aredeemed controllable.

(iii) Calculate the mixture and yield variances.

(iv) Calculate the total variances for the batch.

(b) Balanced score card and performance measurement systemendeavours to create a blend of strategic measures, outcomes

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and drive measures and internal and external measures.Discuss the statement and explain the major components of abalanced score card.

(c) Explain clearly the terms Resource Smoothing and ResourceLevelling.

Answer

(a) Details of original and revised standards andactual achieved

Original standards Revised standards Actual

Fruit 400 Kgs

Rs16

Rs6,400 400 Kgs Rs

19

Rs7,600 428 Kgs Rs

18

Rs7,70

4

Glucose 700 Kgs

Rs10

Rs7,000 700 Kgs

Rs12

Rs 8,400 742 Kgs Rs

12

Rs

8,904

Pectin 99 Kgs Rs

33.2

Rs

3286.8

99 Kgs Rs

33.2

Rs

3286.8

125KgsRs

32.8

Rs

4,100

Citric

acid

1 Kg Rs 200 Rs 200 1 Kg Rs 200 Rs 200 1 Kg Rs 95 Rs 95

1,200 kgs Rs16,88

6.8

1,200 kgs Rs19,48

6.8

1,296 kgs Rs20,8

03

Labour Rs 585.0 Rs 585.0 Rs 600

1,200 kgs 17,471.8 1,200 kgs 20,071.8 1,296 kgs 21,403

Loss 36 kgs 36kgs 132

1,164kgs Rs

17,471.8

1,164kgs Rs

20,071.8

1,164 Kgs Rs

21,403

(i) Planning variances

* Fruit extract (6,400 less 7,600) Rs1,200(Adverse)

Glucose syrup (7,000 less 8,400) Rs1,400(Adverse)

Total Rs2,600(Adverse)

* (Std qty Std price less Std qty

Revised Std price)

(ii) Ingredients operating variances

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Total (19,486.8 less 20,803) = Rs 1,316.2(Adverse)

Ingredients Price variance

(Revised Material Price Actual Material Price) ( ActualQty Consumed)

Variance in Rs

Fruit extract (19 18) 428 428(F)

Glucose syrup Nil

Pectin (33.2 32.8) 125

50(F)

Citric acid (200 95) 1 105(F)

583(F)

Usage variance

(Std Qty on Actual Production less Actual Qty on Actual Production) Revised Std

Price/Unit

Rs Variance in Rs

Fruit extract (400 428) 19

532(A)

Glucose syrup (700 742)

12

504(A)

Pectin (99 125)

33.2863.2(A)

Citric acid Nil

1,899.2(A)

(iii) Mix Variance

(Actual usage in std mix less Actual usage in actual mix ) std price

Variance inRs

Fruit extract (432 428) 19 76(F)

Glucose syrup (756 742) 12 168 (F)

Pectin (106.92 125)

33.2600.3(A)

Citric acid (1.08 1) 200 16(F)

340.3 (A)

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Yield variance

(Actual yield Std yield from actual output) Std cost per unit ofoutput

= (1,164 1,296 0.97) 1164

8.19486= 1,558.9(A)

Labour operating variance

585 600 = 15(A)

(iv) Total variance = Planning variance + Usage Variance +Price Variance + labour operating Variance.

Or Total Variance = (2,600) + ( 1,899.2 ) + 583 + (15) =3931.2 (A).

(b)The balanced score card translates an organization's mission andstrategy into a comprehensive set of performance measures thatprovides the framework for implementing its strategy. Thebalanced score card does not focus solely on achieving financialobjectives. It is an approach, which provides information tomanagement to assist in strategic policy formulation andachievement. It emphasizes the need to provide the user with aset of information, which addresses all relevant areas ofperformance in an objective and unbiased manner. As amanagement tool it helps companies to assess overallperformance, improve operational processes and enablesmanagement to develop better plans for improvements.

Major components of a balanced scorecard - The components ofbalanced score cards varies form business to business. A welldesigned balanced scorecard combines financial measures ofpost performance with measures of firm's drivers of futureperformance. The specific objectives and measures of anorganization-balanced scorecard can be derived from the firm'svision and strategy. Generally, balanced score card has thefollowing four perspectives from which a company's activity canbe evaluated.

(i) Financial perspective: Financial perspective measures theresults that the organization delivers to its stakeholders. Themeasures are: operating income, revenue growth, revenuesfrom new products, gross margin percentage, cost reductionin key areas, economic value added, return on investment.

(ii) Customer perspective: The customer perspectiveconsiders the business through the eyes of customers,measuring and rejecting upon customer satisfaction.

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The measures are: - market share. customer satisfaction,customer retention percentage, time taken to fulfilcustomer's requests.

(iii) Internal business perspective: The internalperspective focuses attention on the performance of the keyinternal processes, which drive the business such asinnovative process, operation process and post-salesservices.

(iv) Learning & growth perspective: The measure are:-employee education & skills levels, employee turnover ratio,information system availability, percentage of employeesuggestion implemented etc.

(c) Resource Smoothing: It is a network technique used forsmoothening peak resource requirement during different periodsof the project network. Under this technique the total profitduration is maintained at the minimum level. The resourcesrequired for completing different activities of profit aresmoothened by utilising floats available on non-critical activities.

These non-critical activities having floats are rescheduled orshifted so that a uniform demand on resources is achieved. Theconstraint is on the profit duration time.

Resource Levelling: It is also a network technique used forreducing the requirement of particular resource due to itspaucity. It utilizes the large floats available on non-criticalactivities of the project and thus cuts down the demand on theresources.

In resource levelling, the maximum demand of a resource shouldnot exceed the available limit at any point of time. To achievethis, non-critical activities are rescheduled by utilising theirfloats. It may lead to enlarging the completion time of theproject. The constraint here is on the limit of the resourceavailability.

Question 3

(a) During the last 20 years, KL Ltds manufacturing operation hasbecome increasingly automated with Computer-controlled robotsreplacing operators. KL currently manufactures over 100

products of varying levels of design complexity. A single plantwise overhead absorption rate, based on direct labour hours, isused to absorb overhead costs.

In the quarter ended March, KLs manufacturing overhead costs

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were:

(Rs.000)

Equipment operation expenses 125

Equipment maintenance expense 25

Wages paid to technicians 85

Wages paid to Store men 35

Wages paid to despatch staff 40

310

During the quarter, the company reviewed the Cost AccountingSystem and concluded that absorbing overhead costs toindividual products on a labour hour absorption basis ismeaningless. Overhead costs should be attributed to productsusing an Activity Based Costing (ABC) system and the followingwas identified as the most significant activities:

(i) Receiving component consignments from suppliers

(ii) Setting up equipment for production runs

(iii) Quality inspections

(iv) Despatching goods as per customers orders.

It was further observed that in the short-term KLs overheadsare 40% fixed and 60% variable. Approximately, half thevariable overheads vary in relating to direct labour hoursworked and half vary in relation to the number of qualityinspections.

Equipment operation and maintenance expenses areapportioned as:

Component stores 15% , manufacturing 70% and goodsdispatch 15%

Technicians wages are apportioned as :

Equipment maintenance 30% , set up equipment forproduction runs 40% and quality inspections 30%

During the quarter :

(i) a total of 2000 direct labour hours were worked (paid atRs. 12 per hr.)

(ii) 980 components consignments were received from

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suppliers

(iii) 1020 production runs were set up

(iv) 640 quality inspections were carried out

(v) 420 orders were dispatched to customers.

KLs production during the quarter included components R, Sand T. The following information is available:

Component

Component

Component

R S T

Direct labour Hrs worked 25 480 50

Direct Material Rs. 1,200 Rs.2,900

Rs. 1,800

ComponentConsignments Recd.

42 24 28

Production runs 16 18 12

Quality Inspections 10 8 18

Orders (goods)despatched

22 85 46

Quantity produced 560 12,800 2,400

Required:

(1) Calculate the unit cost of R, S and T components, using KLsexisting cost accounting system.

(2) Explain how an ABC system would be developed using theinformation given. Calculate the unit cost of components R,S and T using ABC system.

(b) An electronics firm which has developed a new type of fire-alarmsystem has been asked to quote for a prospective contract. Thecustomer requires separate price quotations for each of thefollowing possible orders:

Order Number of fire-alarm systems

First 100

Second 60

Third 40

The firm estimates the following cost per unit for the first order:

Direct materials Rs. 500

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Direct labour

Deptt. A (Highly automatic) 20 hours at Rs. 10 per hour

Deptt. B (Skilled labour) 40 hours at Rs. 15 per hour

Variable overheads 20% of direct labour

Fixed overheads absorbed:

Deptt. A Rs. 8 per hour

Deptt. B Rs. 5 per hour

Determine a price per unit for each of the three orders,assuming the firm uses a mark up of 25% on total costs andallows for an 80% learning curve. Extract from 80% Learningcurve table:

X 1.0 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0

Y%

100.0

91.7 89.5 87.6 86.1 84.4 83.0 81.5 80.0

X represents the cumulative total volume produced to dateexpressed as a multiple of the initial order.

Y is the learning curve factor, for a given X value, expressed as a

percentage of the cost of the initial order.

Answer

(a) (1) Single factory direct labour hour overhead rate =

2,000

3,10,0Rs= Rs 155 per direct labour hour

Computation of unit cost ( existing system)

R (Rs) S(Rs) T(Rs)

Direct labourcost @ Rs 12per hour

300 5,760 600

Direct material 1,200 2,900 1,800

Overheads(direct labour hours Rs 155 perhour

3,875 74,400 7,750

5,375 83,060 10,150

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QuantityProduced (No)

560 12,800 2,400

Cost per unit 9.60 6.49 4.23

(2) ABC system involves the following stages,

1. Identifying the major activities that take place in anorganisation.

2. Creating a cost pool /cost centre for each activity

3. Determining the cost driver for each activity

4. Assigning the cost of activities to cost objects (e.g.

products, components, customers etc)

The most significant activities have been identified e.g.receiving components consignments from suppliers, settingup equipment for production runs, quality inspections, anddespatching orders to customers. The following shows theassignment of the costs to these activities,

(Rs,000)

Receivi

ng

supplies

Set

ups

Quality

inspecti

on

Despatc

h

Total

Equipment operation

expenses

18.75 87.5

0

18.75 125

Maintenance 3.75 17.5

0

3.75 25

Technicians wages

initially allocated to

Maintenance(30% of Rs

85,000= Rs 25,500 and

then reallocated on same

basis on maintenance)

3.83 17.8

5

3.82 25.5

Balance of technicians

wages allocated to set

ups and quality

inspections

34.0

0

25.50 59.5

0

Stores wages - Receiving 35 35

Despatch wages -

Despatch

40 40

61.33 156.

85

25.50 66.32 310

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Note : Equipment operation expenses and Maintenanceallocated on the basis 15%,70% and 15% as specified in thequestion.

The next stage is to identify the cost drivers for each activityand establish cost driver rates by dividing the activity costsby a measure of cost driver usage for the period. Thecalculations are as follows :-

Receiving supplies (980

61,33Rs) = Rs 62.58 per component.

Performing set ups (1,020

1,56,8) = Rs 153.77 per set up

Despatching goods (420

32,66) = Rs 157.93 per despatch

Quality inspection (640

50,25) = Rs 39.84 per quality inspection

Finally, costs are assigned to components based on their costdriver usage. The assignments are as follows,

R (Rs) S(Rs) T(Rs)Direct labour 300 5,760 600

Directmaterials

1,200 2,900 1,800

Receivingsupplies

2,628.36 1,501.92 1,752.24

Performing setups

2,460.32 2,767.86 1,845.24

Quality

inspections

398.40 318.72 717.12

Despatchinggoods

3,474.46 13,424.05 7,264.78

Total costs 10,461.54 26,672.55 13,979.38

No of unitsproduced

560 12,800 2,400

Cost per unit 18.682 2.08 5.82

For components, the overhead costs have been assigned as

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follows,

(Component R)

Receiving supplies (42 receipts at Rs 62.58)

Performing set ups (16 production runs at Rs 153.77)

Quality inspections (10 at Rs 39.84)

Despatching goods ( 22 at Rs 157.93).

(b) (i) Price per unit for first order of 100 units

Rs Rs

Directmaterial

500.00

Direct labour Dept A 20 Hrs @ 10 = 200

Dept B 40 Hrs @ 15 = 600

800.00

VariableOverhead

20% of Rs 800 160.00

FixedOverhead

Dept A 20 Hrs @ 8 = 160

Dept B 40 Hrs @ 5 = 200

360.00

Total cost 1,820.00

Profit 25% 455.00

Selling priceper unit

2,275.00

(ii) Price per unit for second order of 60 units

Learning will be applicable only in department B.

Cumulative output becomes 100 units + 60 units = 160 unitsi.e 1.6 times for which learning is 86.1 % from the tables.

Therefore Total Hrs for 160 units = 160 units 40 .861 =

5,510.4 HrsTherefore Hrs for 60 units = Hrs for 160 units less Hrs for100 units

Or 5510.4 less 40 100 = 1510.4 Hrs

Therefore Hrs per unit =60

4.1510= 25.17

Calculation of selling price per unit

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Rs

Direct materials 500.00

Direct labour Dept A 20 Hrs @ 10 =200

Dept B 25.17 Hrs @ 15= 377.55

577.55

VariableOverhead

20% of 577.55 115.51

Fixed Overhead Dept A 20 Hrs @8= 160

Dept B 25.17 Hrs

@5=125.85

285.85

Total cost 1,478.91

Profit 25% 369.73

Selling price perunit

1,848.64

(iii) Price per unit for third order of 40 units

Cumulative output becomes 100 + 60 + 40 = 200 units i.e. 2times for which learning is 80% from the table

Total Hrs for 200 units = 200 40 .80 = 6,400 Hrs

Hrs for 40 units = Hrs for 200 units less Hrs for 160 unitsOr 6,400 less 5510.4 = 889.6 Hrs

Therefore Hrs per unit =40

6.889= 22.24

Calculation of selling price per unit

RsDirect materials 500.00

Direct labour Dept A 20 Hrs @ 10 =200.00

Dept B 22.24 @ 15 =333.60

533.60

Variable Overhead 20% of 533.60 106.72

Fixed Overhead Dept A 20 Hrs @ 8 = 160

Dept B 22.24 Hrs @ 5 =111.20

271.20

Total cost 1,411.52

Profit 25% 352.88


1,764.40

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Question 4

(a) The diverse use of routinely recorded cost data give rise to afundamental danger information prepared for one purpose canbe grossly misleading in another context.

Discuss to what extent the above statement is valid and explainyour conclusion.

(b) Explain different types of Competitive pricing ?

(c) R Ltd. has spare capacity in two of its manufacturingdepartments Department 4 and Department 5. A five-dayweek of 40 hours is worked, but there is only enough internalwork for 3 days per week so that 2 days per week (16 hours)could be available in each department. R Ltd. has sold this timeto another manufacturer, but there is some concern about the

profitability of this work.

The accountant has prepared a table giving the hourly operatingcost in each department. The summarised figures are as follows:

Department 4 Department 5Rs. Rs.

Power costs 40 60Labour costs 40 20

Overhead costs 40 40120 120The labour is paid on a time basis and there is no charge in theweekly wage bill whether or not the plant is working at fullcapacity. The overhead figures are based on firms currentoverhead absorption rates (fixed and variable) when thedepartments are operating at 90% of full capacity (assume a 50week year). The budgeted fixed overhead attributed todepartment 4 is Rs. 36,000 p.a. and that for Deptt. 5 Rs.50,400 p.a.

As a short term measure the company has been selling

processing time to another manufacturer @ Rs. 70 per hour ineither departments. The customer is willing to continue thisarrangement and to purchase any spare time available, but RLtd. is considering the introduction of a new product on a minorscale to absorb the spare capacity.

Each unit of the new product would require 45 minutes in Deptt.4 and 20 minutes in Deptt. 5. The variable cost of the requiredinput material is Rs. 10 per unit. The market study indicated asfollows:

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(i) with a selling price of Rs. 100, the demand would be 1,500units p.a.

(ii) with a selling price of Rs. 110, the demand would be 1,000units p.a.

(iii) with a selling price of Rs. 120, the demand would be 500units p.a.

You are required to calculate the best weekly programme for thespare time in the two manufacturing departments, to determinethe best price to charge for the new product and to quantity theweekly gain that this programme and price should yield.

Answer

(a) A database should be maintained with costs appropriately codedand classified so that relevant cost information can be extractedto help managers make better decisions. Future costs ratherthan past costs are required for decision making. Thereforecosts extracted from the data base should be adjusted to make itrelevant for that purpose. For example, consider a situationwhere a company is negotiating a contract for the sale of one ofits products with a customer in an overseas country which is notpart of the normal market. If the company has temporary excess

capacity and the contract is for 100 units for the month only,then the direct labour cost will remain the same irrespective ofwhether the contract is undertaken or not. The direct labourcost will therefore be irrelevant. Let us now assume that thecontract is for 100 units per month for three years and thecompany has excess capacity. For long term decisions, directlabour will be relevant cost because if the contract is notundertaken, direct labour can be deployed or made redundantUndertaking the contract will result in additional labour costs.

(b) Where a company sets its price mainly on the consideration ofwhat its competitors are charging, its pricing under such

situation is called competitive pricing. Two types of competitivepricing are:

(i) Going rate Pricing - under this method, the firm tries tokeep its price at the average level charged by the industry.Such pricing is useful where it is difficult to measure costs.Adoption of such pricing will not only yield fair return butwould be least disruptive for industrys harmony. Underhighly competitive conditions in homogenous product market(such as food, raw materials and textiles) the company hasno pricing decision to make.

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(ii) Sealed bid pricing Competitive pricing is adopted insituations where firms compete for jobs on the basis of bids.

The bid is the firms offer price, and it is a prime example ofpricing based on the expectations of how competitors willprice rather than on a rigid relation based on the concernsown costs or demand. The objective of the firm in biddingsituation is to get the contract and therefore it tries to set itsprices lower than the other bidding firms.

(c) The relevant cost of producing the new product is the variablecost plus the lost contribution from selling the processing time toanother manufacturer. It is given that, the main product will

absorb 3 days per week.

Calculation of variable overhead rates

Dept. 4 Dept. 5

Normal Hrs.per annum

(0.940 hr50 wks)

1,800 hrs 1,800hrs

Fixed O.H. rate/hr.(Rs.)

20(36,000/1,800)

28(50,400/1800)

Total O.H. rate/hr(given) (Rs.)

40 40

Thus variable OHrate/hr (Rs.)

20 12

The variable costs per hour are:

Department 4 : Power Cost Rs 40 + Variable Cost Rs 20 = Rs 60

Department 5 : Power Cost Rs 60 + Variable Cost Rs 12 = Rs 72

Note: labour costs are fixed (given).

If the new product is not developed, dept. 4 shall sell unusedprocessing time at Rs. 70 per hour. It is not profitable for Dept. 5

to sell processing time at Rs. 70 per hour since the variable costsis more at Rs. 72. Therefore the relevant cost per processinghour are

Dept. 4 Rs. 70 (Rs. 60 variable cost + Rs. 10 lost contribution forselling processing time)

Dept. 5 Rs. 72

Relevant cost for producing the new product

Rs

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Direct Material (Given) 10.00

Dept. 4, variable operating cost (0.75 hr Rs. 70) 52.50

Dept. 5 variable operating cost (0.33 hr. Rs. 72) 24.00

Relevant cost 86.50

Additional contribution for various sellingprices/demand levels

Rs. Rs. Rs.


100 110 120

Restricted demand(Units)

* 1067 1000 500

Relevant cost (Rs) 86.50 86.50 86.50

Contribution (Rs) 13.50 23.50 33.50

Total Contribution(Rs)

14,404.50 23,500 16,750

*Dept 4 (800 Hrs

3

4) = 1,067 units

*

Dept. 5(800 Hrs 3) = 2400 unitsHence selling 1000 units @ Rs. 110 per unit will achieve

optimum contribution.

Computation of spare time for production of 1,000units pa

Department 4

Department 5

Time required per unit (Hours)

4

3

3

1

Total time for producing 1,000units (Hours)

750 334

Time available (Hours) 800 800

Spare time (Hours) 50 466

Spare time per week (Hours) 1 9.32

Therefore Dept 4 can sell 1 hr. per week at Rs. 70 per hour.

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It is not profitable to sell spare capacity of 9.32 hrs. / week at theexisting rate of Rs. 70 per hour.

Weekly gain from this programme

Rs.

Selling price 110

Variable cost

Direct materials 10

Dept. 4 variable operating cost 0.7560 45

Dept. 5 variable operating cost 0.3372 24

79Contribution / unit 31

Weekly sale 20 units

Additional contribution / week 620

Plus contribution of selling 1 hr (selling price variable cost = 70-60)

10

Total contribution 630

Without the new product the weekly contribution

16 hours Rs. 10 per hr

160

Additional gain for introducing the new product 470

Question 5

(a) Because a single budget system is normally used to serveseveral purposes, there is a danger that they may conflict witheach other. Do you agree? Discuss.

(b) AB Cycles Ltd. has 2 divisions, A and B which manufacturebicycle. Division A produces bicycle frame and Division Bassembles rest of the bicycle on the frame. There is a marketfor sub-assembly and the final product. Each division has beentreated as a profit centre. The transfer price has been set at thelong-run average market price. The following data are availableto each division:

Estimated selling price of final product Rs. 3,000 p.u.

Long run average market price of sub-assembly

Rs. 2,000 p.u.

Incremental cost of completing sub-assembly in division B

Rs. 1,500 p.u.

Incremental cost in Division A Rs. 1,200 p.u.

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Required:

(i) If Division As maximum capacity is 1,000 p.m. and sales tothe intermediate are now 800 units, should 200 units betransferred to B on long-term average price basis.

(ii) What would be the transfer price, if manager of Division Bshould be kept motivated?

(iii) If outside market increases to 1,000 units, should Division Acontinue to transfer 200 units to Division B or sell entire

production to outside market?

(c) Determine the selling price per unit to earn a return of 12% net

on capital employed (net of Tax @ 40%).

The cost of production and sales of 80,000 units per annum are:

Material Rs. 4,80,000 Labour Rs. 1,60,000

Variableoverhead

Rs. 3,20,000 Fixedoverhead

Rs. 5,00,000

The fixed portion of capital employed is Rs. 12 lacs and thevarying portion is 50% of sales turnover.

Answer

(a) A single budget system may be conflicting in planning andmotivation, and planning and performance evaluation roles asbelow:

(i) Planning and motivation roles Demanding budgets thatmay not be achieved may be appropriate to motivatemaximum performance but they are unsuitable for planningpurposes. For these, a budget should be a set based oneasier targets that are expected to be met.

(ii) Planning and performance evaluation roles For planningpurposes budgets are set in advance of the budget periodbased on an anticipated set of circumstances or

environment. Performance evaluation should be based on acomparison of active performance with an adjusted budgetto reflect the circumstance under which managers actuallyoperated.

(b) (i) In this case there are two options available

(a) Sell at the sub assemblystage (after completion of Div.A) @ Rs. 2000/-

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Incremental cost in Div. A Rs 1,200/-

Contribution Rs 800/-

(b) Sell at the final product stage Rs. 3,000

Cost at Div. A and Div. BRs(1200+1500)

Rs 2,700

Contribution Rs 300

Therefore it is profitable to sell at the subassembly stagebecause of higher contribution, provided there is a market.

Hence, if there is market at intermediate stage, first priority

is to sell intermediary (sub assembly). Therefore, 800 unitsshould be sold as sale of intermediary.

The balance capacity available of (1000 800) = 200 unitsshould be transferred to B and B should complete theassembly and sell as final product, since the company canearn Rs. 300 per unit for each unit of such sale.

(ii) If B Div. receives the subassembly at market price of Rs.2,000, plus its own incremental cost of Rs. 1,500 will givetotal cost of Rs. 3,500, thereby yielding a loss of Rs. 3500 Rs. 3000 = Rs. 500 per unit, whereas the company makes aprofit of Rs. 300 per unit.

In order to keep the manager of Div. B motivated, the profitearned of Rs. 300 per unit should be shared between A andB. Hence transfer price will be variable cost of Div. A + 50%of profit earned in the final product = 1200 + 150 = Rs.1,350

(iii) Both Div. A and the Company make higher contribution byselling to intermediate market. If the market demandincreases to 1,000 units, the full quantity should be soldoutside as intermediary and nothing should be transferred toDiv. B.

(c) Return of 12% net (after tax of 40%) on capital employed isequivalent to 12% (1 0.4) = 20% (gross) on capital employed.

Let selling price per unit to be x

Since Total sales = Total cost + profit

i.e. 80,000 x = 14,60,000 + 20% (12,00,000 + 0.5

80,000x)

or, 80,000 x = 14,60,00 + 2,40,000 + 8,000x

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or, 72,000 x = 17,00,000

or, x =000,72

00,00,17= Rs. 23.61

Hence selling price per unit will be Rs. 23.61

Question 6

(a) Explain which features of the Service organisations may createproblems for the application of activity-based costing.

(b) A company manufactures two products A and B, involving three

departments Machining, Fabrication and Assembly. Theprocess time, profit/unit and total capacity of each departmentis given in the following table:

Machining

(Hours)

Fabrication

(Hours)

Assembly

(Hours)

Profit

(Rs).

A 1 5 3 80

B 2 4 1 100

Capacity

720 1,800 900

Set up Linear Programming Problem to maximise profit. Whatwill be the product Mix at Maximum profit level ?

(c) A product comprised of 10 activities whose normal time and costare given as follows:

Activity Normal Time(days)

Normal cost

1-2 3 50

2-3 3 5

2-4 7 70

2-5 9 120

3-5 5 42

4-5 0 0

5-6 6 54

6-7 4 67

6-8 13 130

7-8 10 166

Indirect cost Rs. 9 per day.

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(i) Draw the network and identify the critical path.

(ii) What are the project duration and associated cost ?

(iii) Find out the total float associated with each activity.

Answer

(a)The following may create problem for adoption of ABC system inservice organisation

(i) Facility sustaining costs (such as property, rents etc.)represent a significant portion of total costs and may only beavoidable if the organisation ceases business. It may be

impossible to establish appropriate cost drivers.

(ii) It is often difficult to define products where they are ofintangible nature. Cost objects can therefore be difficult tospecify.

(iii) Many service organisations have not previously had acosting system and much of the information required to setup a ABC system will be non-existent. Therefore introductionof ABC may be expensive.

(b) Maximize z = 80x + 100y subject to x + 2y 720

5x + 4y 1800

3x + y 900

x 0 y 0

where x = No. of units of A

y = No. of units of B

By the addition of slack variables s1, s2 and s3 the inequalitiescan be converted into equations. The problem thus become

z = 80x + 100y subject to x + 2y + s1 = 720

5x + 4y + s2 = 1800

3x + y +s3 = 900and x 0, y 0, s1 0, s2 0, s3 0

Table I

80 100

0 0 0

Profit/unit

Qty. X Y S1 S2 S3

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S1 0 720 2 1 0 036

2

720=

S2 0 1800

5 4 0 1 0 1800/4= 450

S3 0 900 3 0 0 1 900/1 =900

Netevaluationrow

80 100

0 0 0

1800 720 4/2 = 360 900 - 7201/2 = 540

5 I2 = 3 3 - 1 = 5/2

4 2 2 =0 I 2 1/2 = 0

0 - I2 = - 2 0 I 1/2 =- 1/2

I - 02 = I 0 0 1/2 = 0

0 - 02 = 0 I- 01/2 = I

Table 2:80 10

00 0 0

Progra

m

Profit/

unit

Qt

y.

X Y S1 S2 S3

Y 100 360

I 0 0 360

1/2=720

S2 0 360

3 0 2 1 0 360

3=120

S3 0 540

5/2

0

1/2

0 I 540

5/2=216

Netevaluat

ion row

30 0

50

0 0

360 360 1/6 = 300 540 360 5/6 = 240

- 3 1/6 = 0 5/2 3 5/6 = 0

1- 0 1/6=1 0 0 5/6 = 0

- -2 1/6 = 5/6 -1/2 - -2 5/6 = 7/6

0 1 1/6 = - 1/6 0 1 5/6 = -5/6

0 0 1/6 = 0 1-0 5/6 = 1

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Indirect cost (329) = 288

992

(iii) Calculation of total float

Activity Nt(days)

EF LF Float (LFEF)

1-2 3 3 3 0

2-3 3 6 7 1

2-4 7 10 12 2

2-5 9 12 12 0

3-5 5 11 12 1

4-5 0 10 12 2

5-6 6 18 18 0

6-7 4 22 22 0

6-8 13 31 32 1

7-8 10 32 32 0

32

Cost Mangt CA Accounts

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